With active managers losing billions in assets under management weekly, in many cases regardless of performance, as the great tsunami sweep funds away from the "2 and 20" (or even 0.5% and nothing) crowd to passive management, funds have become increasingly desperate to figure out how to preserve this dying business model, with its high fees and generous margins, in a time when the asset management - whether passive or active - industry can barely outperform the stock market. In the case of Blackrock, that has meant fusing active management with robotic quants, and the result has been... a debacle.
According to Bloomberg, BlackRock’s main quantitative hedge-fund strategies, which like RenTec but only with far less success, use computer models to sort through vast amounts of data to pick out patterns, were on track for losses in 2016, and of the strats, four were set for their worst returns on record, data through November showed. A separate investor presentation with a broader quant lineup showed that almost two-thirds underperformed.
Blackrock joined many other traditional hedge fund managers in the shift to quant investing last year in hopes of scooping up that elusive extra alpha; Fink combined the group, which previously had been one of the asset manager's top performers, with the stock-picking unit early last year to lift returns and lure clients to higher-fee products. Demand for low-cost exchange-traded funds helped BlackRock maintain its position as the world’s biggest asset manager, but also has led to record withdrawals from its U.S. active funds business and chipped away at revenue.
Kyle Sanders, an analyst at Edward Jones, told Bloomberg that "quant is key to salvaging BlackRock’s active business. This is one way to improve their performance and distinguish themselves from the pack. Unfortunately, they have yet to deliver.” The silver lining is that with much of the rest of Wall Street's quants also "failing to distinguish" themselves, at least Blackrock does not stand out.
As Bloomberg accurately notes, BlackRock’s quant push reflects the broader pressures convulsing the money management industry. High costs and middling returns (thanks central bankers) have caused investors to spurn active managers in favor of ETFs. To cope, many managers have turned to computer-driven strategies to gain an edge. That even includes some of the most storied names in the hedge-fund world, like Paul Tudor Jones and Ray Dalio, who have jumped on the quant bandwagon to bolster performance - and justify their hefty fees. The only problem is that many, if not all, of these quants systems use the same signals, which leads to not only massive crowding and a reduction in liquidity, it makes outperformance virtually impossible as everyone chases the same trades.
Putting the company's attempt to revive its active-quant business in context, at $282 billion, BlackRock’s active equity business constitutes just a small part of the $5.1 trillion behemoth. Still, it’s an important one for BlackRock because the funds carry much higher fees than its ETFs. For example, the $21.7 billion BlackRock Equity Dividend Fund has an expense ratio of 0.69 percent, data compiled by Bloomberg show. That’s 17 times higher than its $92.1 billion iShares Core S&P 500 ETF, which has an expense ratio of just 0.04 percent. This means that in the first nine months of 2016, its active equity business alone accounted for 16 percent of BlackRock’s base fees, even though it made up 6 percent of AUM. Over the years, it has also been one of Fink’s biggest headaches.
And this is where the robotic rescue team arrives.
With returns for the group’s fundamental active equity funds consistently lagging behind many of its rivals, even after improving in 2016, it suffered broad redemptions, which contributed to a record $19.3 billion of outflows from its U.S.-based active fund business last year. The $78 billion quant team, which BlackRock dubbed Scientific Active Equity, or SAE, was supposed to help fix that. In addition to combining SAE with its stock pickers, BlackRock armed them with the team’s analytical tools.
“As people get the data and learn how to use the data, I think that there is going to be alpha generated and, therefore, will give active managers more opportunity than they’ve had in the past to actually create returns,” BlackRock President Rob Kapito said at a Barclays conference in September.
Unfortunately, as more have turned to the same strategies, it means the "robotic" returns have dwindled: BlackRock inherited the three-decade-old quant business with its purchase of Barclays Global Investors in 2009. Initially, the group was a big success under new management, delivering outsize returns. More recently, things haven’t panned out quite as well. According to BlackRock’s most recent publicly available figures contained in its third-quarter earnings report from October, the strategies beat 31 percent of its peers or a benchmark over a one-year period. That’s slightly worse than its traditional stock pickers, who exceeded their yardsticks half the time.
Worse, according to Bloomberg, at least three of the quant strategies used by BlackRock’s global hedge fund platform have suffered losses greater than 10 percent in the year through November. That compares with an average return of 3.6 percent for quant funds, One would think that massive size, in the case of the world's biggest asset manager Blackrock, would also mean scale.
It has not. Some examples:
The biggest decline was in BlackRock’s $768 million 32 Capital fund, a global long-short equity fund run by Raffaele Savi that has seen its assets decrease by 34 percent in the one-year period ended October. The fund lost 12.2 percent through November, the worst year-to-date performance in its 15-year history.
Some of the quant group’s deepest losses came in the first few months of the year, when markets plunged before bouncing back sharply in late February. Many quant shops stumbled, but a big reason SAE missed the rebound had to do with BlackRock’s own investment policy. It instructs the team to sell when losses become sizable, regardless of what its mathematical models say, according to a person with direct knowledge of the matter.
Of course, Wall Street is notorious for never taking blame for bad investments, and so it was the "timing's" fault:
“They had the worst timing possible,” Morningstar’s Jason Kephart, who called into question BlackRock’s ability to shift factor weightings on the fly, said in an interview. Whatever the case, performance suffered. The fund class for institutional investors fell 6.9 percent in 2016 and beat only 9 percent of funds in its category, data compiled by Bloomberg show.
To make matters worse, SAE has lost some of its top talent. The departures included Bill MacCartney, a former Google scientist that BlackRock hired in 2015 to help build out machine-learning, and Ryan LaFond, a head researcher and one of the brains behind the firm’s socially responsible funds.
Of course, SAE could rebound from its lackluster performance and plenty of bold-faced quant names had a tough time in 2016. The main computer-driven fund at Leda Braga’s Systematica Investments lost 11 percent last year. Three such funds run by Man Group Plc’s AHL division had losses through September.
And regardless of the industry’s ups and downs, few firms anywhere can match BlackRock’s wherewithal. SAE is made up of more than 90 investment professionals, including 28 Ph.D.s and numerous data scientists. In September, Mark Wiseman, the former head of the Canada Pension Plan Investment Board, was brought in to run the group.
Meanwhile, the withdrawals continue: even as the promise of computer-driven investing helped quant funds amass almost $16 billion in new money in the first 11 months of 2016, BlackRock was largely left out. After getting $1.7 billion in fresh capital in 2015 (and snapping six straight years of multibillion-dollar outflows), SAE once again suffered investor withdrawals last year. Fink hasn’t been shy about his disappointment over the inability of SAE to bring in money in the past.
“The one area where we’ve done quite well is in the model-based equities and we’re still not seeing really any flows,” he said on a fourth-quarter earnings call in 2014. “I am very bullish on building this out as a component of our active equity area and I’m quite frustrated, to be frank, that we haven’t seen the momentum that I would thought we would.”
For now, however, this particular fusion of robots and humans is slowly turning out to be a disaster. While Blackrock has other options, such as its massive ETF platform to fall back on, other active managers, all of whom are suffering the same withdrawals, are nowhere near so lucky, and absent big changes in 2017, extrapolating current trends would mean the extinction of the carbon-based asset managers sometime over the next 20 years.